Noughty boys on trading floor led us into debt-laden fantasy

Larry Elliott

It started with a bust and it ended with an even bigger bust. In between was sandwiched an unsustainable boom. Banks have been humbled. Economists have been found wanting. Geopolitical power began to shift from west to east. That was the noughties that was.

It seems barely five minutes ago that policymakers were fretting about the possible - and, as it turned out, entirely illusory - effects of the millennium bug. Policy was loosened to prevent any deleterious effects from a computer meltdown; the result was to pump even more air into the dotcom bubble.

Britain, hard as it now is to believe, managed to avoid the recession which followed the realisation that most of the overhyped internet companies were duds. When that crisis broke, the Government was able to behave in a classic Keynesian way - boosting growth through higher investment and lower taxes.

This time around, Britain's over-reliance on financial services as a source of growth and tax revenues means the deterioration in the public finances has been more marked in Britain than elsewhere, and from a worse starting point..

But the crisis of the past 2½ years has also exposed vulnerabilities across the entire global economy. During the fat years in the middle of the decade, clear warning signs of trouble ahead were ignored.

Ultimately, the global imbalances did matter. The build-up of personal debt did matter. The willingness of banks and other financial institutions to take ever bigger risks in search of high returns did matter.

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The economics profession thought otherwise. It built sophisticated models showing that markets could not be wrong.

Despite the fact that Wall Street and London seemed to be dominated by young men with too much money and too little sense, the chance of a catastrophic blow-out was viewed as alarmist nonsense.

When the meltdown occurred, there was a sense of disbelief. The fact was, however, that trouble had been festering for 15 years and intensified during the noughties.

After the collapse of communism, industrial production migrated to Asia, and China in particular.

Britain and the US saw a hollowing out of manufacturing and a concomitant growth in the relative importance of financial sectors.

Producers in Asia (and parts of Europe) ran trade surpluses while the Anglo-Saxon economies ran trade deficits. Surplus countries bought assets in debtor countries; the money churning through New York and London kept the US dollar and pound strong, made imports cheaper and allowed policymakers to keep interest rates low. Consumers found their incomes went further and they could borrow cheaply. They spent like it was going out of fashion.

Yet there was a dirty little secret about this supposed perpetual money-making machine. It required debt - and lots of it. The real story of the noughties is how borrowing was used to plaster over the deep structural problems of modern global capitalism. We have almost reached the end of that road, but not quite.

Dhaval Joshi, an economist, describes it well when he says that this has been the decade of three borrowing booms from which three big lessons should be learnt.

The first is that debt-driven growth is eventually unsustainable. To generate growth from borrowing, you have to borrow more, year in, year out. The second is that borrowing binges lead to asset booms, which investors seek to rationalise using arguments such as ''a new paradigm'' or ''a wall of money''.

The final lesson is that the point of maximum danger in any borrowing boom is when borrowing starts to slow, not when it stops. ''However much you borrow and spend this year,'' Joshi says, ''if it is less than last year, it means your spending will go into recession.''

This is an important point given the state of the global economy. Policymakers hope a renewed appetite for debt by companies and households will let governments cut borrowing without causing a second leg to the recession. This looks like a flawed strategy.

It would be rebuilding the global economy on the same jerry-built foundations that caused the crisis in the first place. It also flies in the face of reality: there is little evidence that the private sector has any great desire to load up with more debt.

Instead, governments may have to face up to a stark choice. They can carry on borrowing more, accepting that public sector deficits will spiral, or they can respond to market pressure and start borrowing less.

The latter seems the likeliest, but it would all but guarantee a double-dip recession in 2010.